Visit vanguard.com or contact your broker to obtain a Vanguard ETF or fund prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss in a declining market.

Recently I went through the process of purchasing a map update for my GPS (yes, I realize there are phone apps that provide GPS directions … a discussion of my technology choices is not the focus of this particular blog!). As I was exploring the various options, I found that I could purchase global maps, regional maps, North American maps, or U.S.-only maps (as well as several variants of those basic options). Not seeing the overwhelming pros of purchasing street maps of Europe at this time, I elected to purchase only the maps of the U.S. and Canada and save some money in the process. In other words, there really wasn’t a need to diversify!

However, this got me thinking about how polar-opposite my GPS decision was to the decisions I’ve made in my own portfolio and the advice we give clients about the need to diversify globally. Specifically, we’ve done a lot of work around the question of “home bias,” or the desire to invest predominantly in your own country, and how to think about the balancing act between home bias and the benefits of investing beyond your borders. A quick review of a report put together by the International Monetary Fund (IMF) shows that as of year-end 2012 (the most recent data available), U.S. investors underweighted international equities by 25 percentage points and international fixed income by 52 percentage points. What the data don’t show is that many investors have much less than the aggregate values shown in the figure below.

While a GPS unit that only shows me the streets of the U.S. and Canada may be optimal for my expected driving patterns over the foreseeable future, a portfolio that invests solely in those same countries is not. In fact, our research has shown that a portfolio that includes investments in both U.S. and non-U.S. equities and fixed income securities has been less risky on average than one exposed to U.S. investments alone (Global equities: Balancing home bias and diversification; Global fixed income: Considerations for U.S. investors). While the empirical evidence bears this out, it’s really quite intuitive. As long as the investments of two countries aren’t identical in their makeup and return patterns over time, there’s an expected benefit to holding both of them. The broader and more diverse a portfolio, the less dependent it is on the returns of any one sector, style, or country. And while a year like the last one makes it difficult to contemplate diversifying the substantial returns of the U.S., there are inevitable periods where the U.S. may be the laggard.

So is there a “right” amount of diversification? Well, that’s where it gets nuanced. Vanguard approaches this question in three steps. First, we strongly believe that unless there is a specific reason for not diversifying, investors are better off with both U.S. and non-U.S. equity and fixed income investments. Second, we believe that an upper limit on the amount of diversification should be a portfolio that reflects the same allocation as the global market. For stocks today, this would result in a portfolio approximately 50% in U.S. equities and 50% in non-U.S. equities. Finally, the actual allocation that each investor lands on between 0% and market-proportional should reflect a number of considerations. For Vanguard Target Retirement Funds and LifeStrategy Funds, we allocate 30% of the equity investments and 20% of the fixed income investments in securities domiciled outside of the U.S. In other words, our funds are in line with the average exposure of U.S. investors on the equity side, and slightly more than double the average exposure on the fixed income side. Within those allocations, we reflect the weights of each country and region proportionally. Of course, while these figures represent a reasonable guide, each individual should consider whether these allocations are right for them. While we all can benefit from diversification, there is no optimal allocation for all investors.

Notes: All investing is subject to risk, including the possible loss of the money you invest.

In a diversified portfolio, gains from some investments may help offset losses from others. However, diversification does not ensure a profit or protect against a loss.

Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk, which is the chance that political upheaval, financial troubles, or natural disasters will adversely affect the value of securities issues by companies in foreign countries or regions; and currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates.

Chris Philips

Christopher Philips, CFA, is a senior investment analyst in Vanguard Investment Strategy Group. In this role, Mr. Philips has published and presented research on various topics, including international investing, indexing, and benchmark selection. Mr. Philips joined Vanguard in 2000 and has worked in the Investment Strategy Group since its inception in 2001. He earned a B.A. from Franklin and Marshall College and is a CFA® charterholder.

Comments

Donald G. | November 13, 2015 11:16 am

Mr. Philips: A very informative article and I could not agree more.I am wondering however how many of my fellow bloggers are talking about diversifying their IRA,s, taxable money,401k’s, 403b’s etc?. Right now I am only managing IRA money. While I do have a substantial savings account to protect my IRA from selling on a downgrade, it basically sits in my credit union.Are all of the articles written by you and other contributors including the whole picture- Tax sheltered and taxable investments that are to be managed together?Diversified together?It is my understanding that once you start to try and diversify the whole package then all kinds of where you place bonds and stocks enter into this discussion.Right now I can rebalance within my IRA and not have to worry about tax questions because I am not at RMD time and Uncle Sam does not see this money as yet.I think that when we look at our finances there is a tendency to write at the position we are in during the article. I do not look forward to having to combine all of this at RMD. time. I am assuming that one would try and use the proceeds from your RMD,s to help you to keep everything in balance for your whole account.I am a committed long term invester and I do not need the proceeds from my Ira to pay any bills. Most of the money will be used as keeping emergency funds built up and to buy any extras that maybe needed into the future.Vanguard has allowed the wife and I to retire very comfortably. Good Luck to All!

Michael W. | November 7, 2014 2:36 pm

I enjoyed your article. It makes logical sense to me.

Originally when I began investing, I saw mutual funds as a prime opportunity to “diversify” and minimize risks. Thinking about the premise of diversification, as we are in a global economy, it seems to make sense to “diversify” the markets where our investments reside. My investment strategy does include international funds but not quite at the 50/50 split. Your article provides very insightful thoughts on the US verses international split that investors should consider.

In the end, it’s the investors choice of mix but sometimes the best and most stable rewards are from exploring a bit of the unknown.

Jim S. | November 6, 2014 8:53 pm

David W. | November 6, 2014 5:52 pm

Diversifying (di-worse-ifying according to Peter Lynch) protects the investor from risk, or extremes. VEU would have “protected” you from gains versus VTI for several years now. Is there any reason to expect things will change? Thank you.

Gerard I. | November 6, 2014 2:29 pm

Vanguard never names a specific fund in any of their stories, it would nice if you suggested two or three specific funds to go with the authors point. For example, what is a good international fund that invests like a traditional balanced fund?

Fred J. | October 8, 2014 7:39 pm

I use 70% Total Stk Mkt, 30% Total Intl Stk Mkt for my equity portion and the rest(40% of my portfolio) goes to Total Bond Fund. I’m thinking of splitting off 30% of Total Bond fund and putting it into International Bond Fund. So far, so good. On big market down days my portfolio is only down about half what the S&P 500 or the Dow index is.

Thomas M. | September 30, 2014 10:24 pm

VINCENZO M. | September 25, 2014 9:53 am

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At Vanguard, we’ve always believed in candid, direct communication with investors. In fact, it’s one of our core principles. In 2009, we created the Vanguard Blog so that we could talk about what’s happening in our industry and in the economy—and hear what’s on the minds of investors like you. More

Visit vanguard.com or contact your broker to obtain a Vanguard ETF or fund prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss in a declining market.